Tuesday, December 15, 2009

Chemspec International: a Value Play for 2010 and Beyond

2009 is on course to be a great year for investors. But 2010 is unlikely to be a duplicate of 2009. Major setbacks look inevitable down the road. At best, 2010 will turn out to be a stock pickers’ market. So do not expect this year’s top performers to remain such next year. Likewise, some underdogs might just turn out to be doing great in the next year or two.

One of 2009’s underdogs is CPC (Chemspec International). From late June’s IPO price of $9 to Monday’s (12/14/2009) market close of $5.66, CPC has lost 37% of its value. This Chinese specialty-chemicals CMO (Contract Manufacturing Organization) commanded 25% of China’s fluorinated chemicals manufacturing market in 2008, and is China’s largest in this category. However, destocking in the international electronics and agrochemical industries (two end markets CPC serves) has greatly impacted its growth in 2009.

Q3 turned out to be particularly disappointing. Sales decreased 25% and net income decreased 58% year over year. Q4 is set to be ugly as well, with top line projected to decrease 36 to 40% year over year. For FY 2009, revenue is projected to decrease 13 or 14% from 2008.

Not surprisingly, the weak operating performance has been discounted heavily by the market. On Monday (12/14/2009), the stock closed at $5.66. This compares to its book value of $4.90 and net tangible asset value of $4.66 per ADS. My low estimate of the 2009 EPS is about $0.75 per ADS (vs. consensus $0.77). These translate into P/B of 1.15 and P/E (current FY) of 7.55.

If consensus estimate of 2010 EPS ($0.87) turns out to be accurate, the stock is currently trading at 6.51x 2010’s EPS. Also get this: analysts are expecting EPS to grow about 13% in 2010 in other words. That means Q3 and Q4 likely will turn out to be the trough in terms of the company’s operating result.

The consensus estimate looks in line with company’s understanding of its end markets for 2009 and 2010. Management expects its pharmaceutical revenue growth to be in mid teens in percentage terms for 2009. For 2010, it sees similar growth in this segment. For electronic chemicals, 2009 will end up with negative growth. However, industrial sources forecast this industry to recover to the 2008 level in the first half of 2010 and exceed this level in the second half. This implies that this industry will see positive growth for the entire year. For the agrochemicals segment, management expects a slow recovery for the year.

So, all three segments combined might bring in moderate growth in 2010 for the company.

CPC’s cash generating capability is worth noting. For 2008, its operating cash flow amounted to RMB 297 mm on net income of 314 mm. Operating cash flow for Q3 2009 was RMB 89 mm on net income of 53 mm. For the first nine months of 2009, operation has brought in RMB 199 mm of cash flow on net income of 145 mm.

Another thing that grabbed my attention was the company’s recent acquisition of Kangpeng Nong Hua for RMB 25 mm cash. Kangpeng Nong Hua is an agrochemical developer and manufacturer which CPC’s top executives Drs. Tang and Yang had controlling interest in before the acquisition. It produced RMB 113.8 mm of revenue in 2008. The price/sales ratio of 0.22 in the cash transaction appears quite attractive and might be an indication that management is capable of striking attractive deals for all shareholders. Management aims to enter agricultural AI (Active Ingredient) business through this acquisition.

Bottom line, CPC’s current weakness might prove to be a great opportunity in owning a leading Chinese CMO (in fluorinated specialty chemicals industry) that looks poised for intermediate-term (1 year) and longer term growth, at bargain prices. After all, if you have learned anything from 2009’s market performance, the foremost is buying bargains when the public is in panic mode. Those who have panicked in early 2009 are likely to be also those who have missed the historic market rally of 2009!

Disclosure: Long CPC